Once businesses realised that distributors have enormous revenue potential despite having low margins, private equity emerged as a significant player in the distribution industry.
Distribution owners should get their finances in order, play to their strengths, and demonstrate that they are adjusting to changing client demands if they want to attract the interest of possible acquirers.
Build a team with M&A experience to maximise the value of your company and increase the likelihood that the deal will close when it comes time to negotiate and close the deal.
There is more M&A activity than ever before in the distribution sector, as was said in the first part of this series, and there are no indicators that it will slow down. While many businesses are attempting to compete in an environment that is becoming more concentrated, others are prepared to sell or join forces with another company.
44 mergers and acquisitions in the industrial supply and distribution sector were covered by trade publication Industrial Distribution in the first quarter of 2021. Before the pandemic initially paralysed portions of the business sector, the pace of transactions had almost caught up to the 20 or so announcements each month that were then typical.
Some distribution leaders who are willing to sell are prepared to make a profit or are merely taking advantage of kind offers so they may retire or launch a new company. Yet, not all sellers desire to sell their company and move on. Owners who want to stay with the business after an acquisition may believe that their chances of success would increase if they join one of the major distributors or a smaller business in their target market.
Regardless of the driving force, we are here to support distributors as they navigate the difficult and frequently time-consuming process of generating interest in and selling their businesses. We’ll first explain why private equity has shown such interest in the distribution sector before providing advice on how to position your business as a desirable acquisition candidate. We’ll also go through how distributors can increase their value, including how a carefully chosen team of professionals and technology can help.
Private equity emerges as a distribution force
You’ll notice two main sorts of bidders if you read through the Industrial Distribution reports on mergers and acquisitions: fellow distributors and private equity groups. Consolidation in the sector is mostly the result of private equity.
PE Investors See Opportunity
Distributors weren’t viewed by private equity firms as a worthwhile business for many years. They frequently had returns on sales in the low single digits and had narrow margins. Brent Grover observed that it appeared there were many other, superior investing prospects. It wasn’t the standard when Grover sold National Paper & Packaging, his distribution business, to a private equity consortium in 1999 after 25 years of operation.
Yet that opinion has since evolved. With the financial crisis of 2008, private equity activity in the distribution sector began to increase, and it has continued to do so. Due to a high asset turnover ratio, which gauges how effectively a company uses assets to produce sales, private equity leaders understood that distributors could actually be quite successful despite the poor return on sales. Grover claims that distributors frequently have an asset turnover ratio of four, which is higher than that of many other kinds of firms and equals four dollars in sales for every dollar of assets. A manufacturer, for example, would need to make a bigger initial investment to get the same amount of income as a distributor because their asset turnover ratio is normally around two or two and a half.
Distributors are more productive because they don’t need as many fixed assets to run their businesses. A pure distributor doesn’t require the specialised, expensive equipment frequently required for product production. Instead, it transports goods throughout the building and delivers them to clients using readily accessible equipment like trucks and forklifts. Inventory and accounts receivable are a distribution company’s main assets.
The knowledge that these companies could generate money effectively attracted more private equity firms.
For a private equity firm, “a distributor generating a pitiful net 3% pre-tax return on sales might as well be producing a 30% return on equity,” observed Grover. They discovered they could acquire small distributors at reasonably appealing prices, combine them to create a giant distributor, and profit from the increased size of the business because larger businesses often fetch higher multiples than smaller ones.
The state of the market permits large offers
For the past ten or so years, falling interest rates and increased access to credit from lenders have encouraged private equity to expand its presence in the distribution sector. Due to these two variables, PE firms are able to obtain larger loans at competitive rates, enabling them to pay higher distributor prices than in the past.
Grover is reminded of the current situation in 1999, when he sold his family’s company. It was a seller’s market back then, just like it is now, with prices reflecting “unheard-of multiples.” But, the dot-com bubble burst within a short period of time, the 9/11 attacks shocked the nation, and just as the economy was beginning to recover, the financial crisis struck. These occurrences decreased multiples and valuations.
Belzer stated that “everything is just, in my opinion, inflated so high that offers are so tempting that I’m sure it’s extremely easy for a tiny shop to roll up, get paid out, and go on, whether it be the business market or the real estate market.”
Big Distributors Become Into Investors
Of course, there are other investors in this sector besides private equity firms. According to McKinsey research, 27% of the major distributors in the U.S. have acquired at least one additional distributor, up from 20% prior to the Great Recession. Several substantial distributors finance new or rapidly expanding distributors directly or via a venture capital arm. For instance, in 2017, the largest distributor of plumbing and heating equipment, Ferguson, founded Ferguson Ventures. A year later, industrial and technology behemoth Honeywell launched Honeywell Ventures.
According to Chaturbedi, these arrangements give the big players a new source of income, while smaller distributors gain from the resources, reputation, and size of their investment.
How to Get Customers’ Attention
Not everyone is as fortunate as Belzer, who claimed in part one of this series that he receives inquiries from potential buyers almost daily.
In the end, the qualities that distinguish successful companies in a hypercompetitive climate also distinguish those companies as desirable acquisition prospects. Of course, there are some characteristics you have no control over, including where your business is located. An acquirer may determine that buying another business is the best method to build a presence in a particular area. Yet, by acquiring traits you can control, you can also place your name higher on the list of potential targets.
Some of these suggestions will be more applicable than others depending on whether you’re almost ready to sell or just starting to consider purchase options in the distant future. As a result, we have categorised them into three categories: short-term (a few months), medium-term (six months to a year), and long-term (more than one year).
Boost Your Industry Presence in the Near Term
Grover advises joining trade associations and buying clubs, where smaller companies band together to benefit from bulk purchasing savings. These can help you network and build a brand for yourself. For instance, it’s possible that a fellow member who isn’t ready to sell will introduce you to a group that was considering buying his business.
It is not sufficient to merely pay the membership fee to these organisations. Distributors must be engaged members of these groups, attending meetings and maybe serving in leadership capacities.
Decide on a Fair Price
Despite the fact that credit conditions have led to distributor values already reaching historic highs, Grover claimed that one of the biggest mistakes sellers make is setting an inflated asking price for their enterprise. Determining the ideal price is not an easy task, therefore it is best to seek the advice of professionals in order to establish a cost that will satisfy both the market and the ownership. (More on this in the part below.)
Identifying a company’s value is “an art, a science, and it requires experience to do it correctly,” according to Grover.
Medium-Term: Prepare Your Company for the Lights
Acquirers prefer not to purchase poorly run businesses that require a lot of effort, and if they do, they will anticipate paying a considerably lesser price for the business as a result.
Grover added, “It’s like selling your house.” “Better fix your moist basement if you have one. Update your kitchen if it needs to be upgraded.
The fixes that are required vary by industry: Examples include strengthening your inventory management procedures, bringing your receivables up to date so you know which clients owe you money and how much, and making sure you have accurate, readily available financial information. And before looking for buyers, you should secure any outstanding debts to other parties if there are any.
Long-term: Focus on your strong points
Determine the characteristics that set your distribution company apart from rivals and the distinctive value you would offer a customer. You might be a pro at e-commerce, have a large selection of products, or have the ability to deliver goods the same day to a wide area. Concentrating on that quality will raise your value and attract more attention.
“Ideally, you should have something that someone couldn’t possibly create, even if they wanted to, in order to persuade them to buy rather than build. Your main competitive edge is that, says Argov.
IWA was founded in 2004 when Argov and two other investment bankers purchased a company that made wine cabinets, and it has since added five other businesses to its portfolio. IWA paid special attention to buying companies that had a strong brand value””—they had established brands and sizable client bases.”
To be able to manage price and distribution, for instance, IWA added WineKeeper and Rogar, two brands that offered wine preservation systems and wine openers, respectively, to its portfolio of exclusive brands. Subsequently, in an effort to increase its presence in the B2B market, the company acquired Epic Products, which had a presence there.
Prove your dedication to innovation
As discussed in part one, rising competition and a change in B2B purchasing patterns have forced many distributors to reevaluate how they conduct business. Innovation is now essential to this industry’s survival and success. Also, your level of innovation may help you distinguish yourself from competing businesses that potential acquirer may be considering.
How creative are you with the way your business model is set up? said Chaturbedi. “Do you have many revenue sources, various means to draw clients, and multiple ways to solve a certain problem?… When it comes to value, the flexibility of business modelling becomes crucial.
For many distribution organisations, sales were down in 2020, but that is no justification for stagnant innovation. Because they’ve caught up on receivables, have less inventory on hand, and may have gotten a pandemic-related loan, firms in some circumstances have more cash than usual despite the decline in sales, Grover said.
He advised the businesses, “Use those cash to invest in the business and increase its appeal to a buyer.” You’ve discovered through this experience that clients are quite willing to transact business electronically and that they don’t regard salespeople as highly as we previously believed.
Create a Top-Notch Client Acquisition Plan
A tried-and-true customer acquisition method will make distributors stand out, though it won’t be a quick cure, according to Chaturbedi. That is one of the few qualities that a rival can’t easily imitate.
Your strategy can be built around an online sales channel that offers the digital tools that customers are demanding as more and more people make purchases online. This channel can include e-commerce websites, apps, and other self-service tools for account management that allow users to view available credit, pay invoices, request quotes, track orders, and more. Distributors require comprehensive analytical skills that, whenever possible, utilise real-time data. According to Chaturbedi, this aids businesses in comprehending consumer behaviour and trends and in customising the online shopping experience for different customers.
By meeting the changing demands of their clientele, smaller distributors can also stand out from the competition. For instance, their agility can make it simpler for them to find a new line of items that are suddenly in demand or deliver things to a consumer rapidly.
Enhancing the Value of Your Business and Sealing the Contract
The aforementioned strategies will, for the most part, assist you in maximising the worth of your business. The company that is effectively operated and managed, has a tried-and-true client acquisition strategy, and plays to its strengths will unquestionably be worth more than one that doesn’t. The distributor will gain a reputation as the industry pioneer, and when customers inquire, your name will invariably be mentioned.
Grover stated, “It’s not what you say about yourself; it’s what other people say about you in your company’s acquisition search.
Grover suggests maintaining a record of prospective buyers who have contacted your business over the years if it has garnered unsolicited interest. The list should include their contact details. This involves some planning; don’t hang up the phone when they call right away if you think you might sell at some point. You’ll be happy you made this small move later on.
Assemble a team for acquisition
Owners should put together a team to assist them in the negotiation process once they have found the ideal buyer. According to Grover, that team should include a CPA, an attorney with substantial M&A experience, and an advisor who has handled transactions similar to those involving distributors. Businesses all too frequently rely on the same individuals for their financial and legal needs.
Because they didn’t get competent guidance, Grover explained, “distributors relied on their longtime lawyer, who might be a buddy and who might not have expertise selling firms.” “It’s possible that your long-time CPA firm has no experience structuring deals for businesses that are selling. That’s important since it’s your goal to have as much money left over after taxes as you can, and CPAs play a big role in deal structuring.
Distributors will more than make up for the money they spend on these experts by gaining greater value for their companies. Together, they frequently take 2-4% of the selling price.
The likelihood of the deal actually closing also rises when a team with experience in M&A is involved. Take into account that, according to Harvard Business Review, between 70 and 90 percent of mergers and acquisitions fail, and a sizable portion of them do so even after a signed letter of intent.
Understand the function of technology
Don’t undervalue the significance of technology in all of this, to sum up. Technology is not a panacea, but it may offer crucial data that can be used to spot areas that require development and carry out many of the strategies we’ve discussed. To borrow an analogy from earlier, software can help you fix your leaky basement and get your house in order.
For instance, if a distributor wants to reduce the cost of acquiring new customers, it can think about segmenting its audience using a CRM system so it can send more tailored messages that will boost returns. With supply chain management software, you may pinpoint areas of your business where expenses are out of control or productivity has declined and then implement creative fixes. While due diligence is starting, accounting software provides key financial documents to leaders instantly.
When trying to position yourself for a sale, technology enables you to demonstrate that the company can continue operating without you and won’t crumble after the sale, according to Argov. Furthermore, technology will help you run your business more effectively. With better margins, you’ll be a more appealing target and command a higher sale price.
Every little amount of revenue counts. In dozens of small deals Grover reviewed, the median multiple applied to determine a distributor’s value was six (and it usually increases with business size). So, when using a multiple to calculate your company’s EBITDA, even a small increase can have a significant impact.
Of course, this does not advocate eliminating entire departments and cutting costs everywhere feasible in the interest of quick profits. Investors will figure out what you’re doing, and the anticipated effect on your valuation won’t happen.
If your distribution company has shown it can respond to current issues and find methods to draw in and keep consumers, now is an excellent moment to sell. Private equity funds and other companies are very interested in buying these companies, and distributors are fetching high prices.
According to our sources, both large and small businesses will always have a place, although midrange distributors may start to disappear within the next five to ten years.
The bell curve’s middle will collapse, according to Chaturbedi. There will therefore be a very limited number of extremely large players—perhaps 10 or 12—and a very long tail of tiny, specialised players. Some of those may be acquired over time, while others may make their own purchases to broaden their specialised markets.
In general, characteristics that enable distributors to be successful as independent companies also boost their value and make them desirable acquisition targets. Hence, whether they want to sell their business today, in five years, or never, owners and leaders in the distribution industry must commit to projects and technologies that will set their businesses apart from the competition.